Thursday, 7 May 2009

Productivity: what is it good for?

Let me play devils-advocate. In an article from the Dominion Post on May 5, Matt Nolan writes
Productivity is a surprisingly vague term given its importance in economics. The essence of productivity is as follows: when an industry or an economy is more “productive”, it can make more output with the same amount of input.

This definition indicates that productivity isn’t a goal in itself. The goal of policy should be to support domestic economic activity (efficiency), while ensuring that the other issues that society values (equality, fairness, justice, etc) are taken into account. The purpose of an elected government is to balance the often competing goals on the basis of what it appears society wants.
The point missed here is that productivity makes the cake bigger, fighting over how to cut it up-which is what issues like equality, fairness, justice, etc basically amount to-makes it smaller. The real question then is basically, Do you want the same share of a bigger cake or a larger share of a smaller cake?

History teaches us a few things, productivity makes a country wealthier, takes people out of poverty and makes most people better off. Making the cake bigger has real benefits to people. With regard to wages and productivity Paul Krugman has written,
Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World growth hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)
From a paper by Martin Feldstein, Professor of Economics, Harvard University and President and CEO of the National Bureau of Economic Research [he has since retied from the NBER post], given to the American Economic Association on January 5, 2008 we see more evidence on the relationship between productivity and wages. The paper is entitled "Did Wages Reflect Growth in Productivity?" Feldstein writes,
The level of productivity doubled in the U.S. nonfarm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity.

More specifically, the doubling of productivity represented a 1.9 percent annual rate of increase. Real compensation per hour rose at 1.7 percent per year when nominal compensation is deflated using the same nonfarm business sector output price index.

In the period since 2000, productivity rose much more rapidly (2.9 percent a year) and compensation per hour rose nearly as fast (2.5 percent a year).
and later he says
The relation between wages and productivity is important because it is a key determinant of the standard of living of the employed population as well as of the distribution of income between labor and capital. If wages rise at the same pace as productivity, labor’s share of national income remains essentially unchanged. This paper presents specific evidence that this has happened: the share of national income going to employees is at approximately the same level now as it was in 1970.
So when measured correctly, productivity and wage do roughly move together over time. For the US at least.

In other words, people have a higher standard of living because of productivity growth. The cake is bigger and thus we can have more of the things we want. Matt end his article by saying,
Both political parties are unwilling to face that, with respect to government policies, there is a fundamental trade-off between some social values (fairness, justice, etc) and the level of productive activity. This trade-off is one of the primary reasons for the existence of government – and yet neither of the political parties seem willing or able to recognise it.

As a result, next time we hear the government discuss the importance of productivity, or we hear some international body talk about the goal of productivity growth, let’s try not to forget that there is a trade-off – and let's ask exactly what this trade-off is.
I'm not sure the trade-off is as large and important as Matt thinks. It is both possible and much easier to concern oneself with issues of justice and fairness when you are rich, the poor don't have time for it, they are too occupied just making ends meet. Productivity make us rich, it results in a higher standard of living for us. Doesn't sound like much of a trade-off to me.


Matt Nolan said...

Hi Paul,

The article was about policy choices - namely if the government is going to put a policy in place it is inherently trading off between different types of social value (including production).

I completely agree that we want productivity growth, I completely agree that wages rise with productivity, and I completely agree that a rising tide will lift all boats.

However, I still don't think a sole focus on productivity is good policy - and I am dubious about government ability to influence productive efficiency in the first place.

Policies that focus solely on productive efficiency (which is what a productivity target demands) are not necessarily socially optimal. There is no free lunch where the government "makes productivity appear" and we don't lose anything for it - someone will lose.

Now Labour annoyed me because they ignored the importance of productivity. National is annoying me because they seem to act like there is no trade-off.

It might seem to us that we will still have a welfare improvement when moving from one parteo-optimal eqm to another - but I don't know how we can really observe that. If the political parties were honest about the winners and losers we might get a better idea of what society values - and thereby what sort of trade-off society is willing to make.

JC said...

"Productivity make us rich, it results in a higher standard of living for us. Doesn't sound like much of a trade-off to me."

It does to a country that has or currently describes itself as "Godzone", "workingman's Paradise", "best country in the world to raise kids", "best race relations in the world".

NZ's first response to a lift in productivity/wages is to claw back what it believes it lost from 1950.. and to perpetuate the mantra mentioned above.